Public finances

Who's going to pay for it all?

The tough times start next year

GORDON BROWN'S next budget, which he will present in a few weeks' time, comes only a couple of months before the expected election date. It is therefore expected to be a soothing document. Governments that are short of cash do not do exciting budgets before elections. Those looking forward to an interesting budget, according to the Institute for Fiscal Studies, which published its version of the nation's fiscal position on January 26th, will have to wait until next year. They can expect a big tax demand.

The IFS has looked hard at Mr Brown's sums and thinks they don't add up. It calculates that a tax increase of £13 billion—equivalent to 1% of GDP—will be needed in April 2006 to put the public finances on to a more sustainable footing.

Mr Brown aims to meet his “golden rule” of borrowing only to invest. Current revenues must equal or exceed current spending over the economic cycle.

Happily for Mr Brown, the Treasury's forecasts show that he will meet the rule. Adjusting for cyclical conditions, the current budget will be just in surplus when the next economic cycle starts in 2006-07, as the Treasury expects (see chart). The surplus will then steadily increase.

Unhappily for Mr Brown, the IFS sees a bleaker future. It forecasts that the cyclically adjusted current budget will be in deficit when the next cycle starts in 2006-07. And it will stay in the red over the following three years.

The gap between the two forecasts does not arise from differences about the economic outlook. The IFS adopts the Treasury's economic assumptions. Nor does it arise from a disagreement about the amount of tax revenue that's needed in the years ahead. The point at issue is whether that revenue can be achieved with or without a tax-raising budget.

The Treasury is forecasting that the tax take will rise from 38.3% of GDP in 2004-05 to 40.5% in 2009-10 without tax increases. The IFS points out that this increase of 2.2 percentage points is about double what would normally occur thanks to “fiscal drag”, which takes place as earnings growth pushes taxpayers into higher tax brackets. It is forecasting a still hefty increase in the tax take to 39.8% of GDP without tax-raising measures. But that still leaves a gap, which will require tax increases of £13 billion in the 2006 budget.

There are no prizes for guessing who will have to foot the bill. The IFS has worked out the winners and losers from all Mr Brown's measures on taxes and benefits since 1997 (see chart). The pattern, which includes council tax since this is heavily affected by Treasury decisions, speaks for itself. The big gainers are the poorest 20% of the population. The richest have been clobbered hardest. What's more, the pattern of income redistribution has become much more marked in the past four years as Mr Brown has increasingly played Robin Hood.

In Labour's first term, Mr Brown was initially prudent and built up a big treasure-chest. In Labour's second term, the chancellor has run down this surplus and borrowed heavily in order to finance a spending spree. A third term will bring a reckoning, and it promises to be a painful one as voters have to pay for Labour's free-spending ways.